Abstract: This paper discusses and evaluates telecommunications regulatory policy in Japan taking into account the structural changes in the industry. The first section of the paper describes the basic concept of regulation in telecommunications, and is followed by an outline of privatisation, the

introduction of competition in Japan and an analysis of the country's regulatory framework. The following section evaluates the regulatory adjustments made with the development of competition, while the section after analyses structural changes in the industry. We then evaluate the major regulatory reform of 2004. The paper concludes by proposing a total revision of the regulatory framework to accommodate the transition from vertical integration to a layered structure.

Key words: competition, market failure, asymmetric information, vertical integration, layered structure, broadband internet, mobile

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The telecommunications industry is undergoing drastic structural changes with the rapid diffusion of mobile services and the internet. The regulation of POTS (Plain Old Telephone Services) assumes that physical, service and content layers are closely associated and competition is basically within the metallic subscriber line platform. Regulation for 3G mobile and internet services, on the contrary, requires a layered approach, as links between layers are cut off and inter-platform competition becomes significant. The past regulation that mainly focused on the control of the market power of incumbent carriers in local access market should be restructured to accommodate the new structure. Most regulations in the telecommunications industry were basically justified by the existence of market failure. There are three main reasons behind market failure in the telecommunications industry (1).

--the existence of carriers with market power 2,

--asymmetric information between consumers and carriers,

--network externality.

With the structural changes indicated above, these factors are also changing.

The telecommunications industry used to be regarded as a typical example of a natural monopoly. However, with technological development, privileges awarded to the former state monopolies were revised and competition was introduced in the 1980s. The introduction of competition itself did not eliminate market failure, as incumbent carriers have continued to keep de facto monopoly in local telecommunications facilities, especially metallic subscriber lines. The prices of long-distance services and services for business users were set above cost to subsidise local services for residential users which were priced below cost. This price structure encouraged new entrants to move into the long-distance and business markets.

New entrants offered their services by interconnecting with the local network of incumbent carriers that could not be practically or reasonably replicated. Incumbent carriers offered monopolistic wholesale products (access to local network) and competitive retail products (local and long-distance call services). In the context of such market structure, there are two choices in ensuring fair competition: structural separation and conduct regulation.

In the case of the U.S.A., structural separation was adopted in 1984. In many other countries, conduct regulation without structural separation was preferred. Japan is one of the few countries to have introduced competition without taking a clear position between these two choices. Although the structural separation of the incumbent NTT (Nippon Telegraph & Telephone) Public Corporation was debated, the discussion was deferred and the operator was eventually privatised as a unified entity offering both local and long-distance services in 1985. At the same time, one of the most important conduct regulations, namely interconnection rules, was not adequately legislated. Regulatory uncertainty consequently lingered on and the informal asymmetric regulation practised by the regulatory authority to compensate for this shortfall was criticised as non-transparent and arbitrary.

When the regulator finally settled the problem with the introduction of interconnection rules in 1997 and the reorganisation of NTT under a holding company structure in 1999, the industry structure itself began to change. The nature of competition shifted from intra-platform to inter-platform based on a layered structure. This, in turn, should change the pattern of market failure.

Although the MIC (Ministry of Internal Affairs and Communications) (3) introduced revised TBL (Telecommunications Business Law) as of April 2004 to respond to the changes, this legislation was still founded on ideas valid in the POTS era and failed to protect consumers by abolishing virtually any regulation of prices. Structural changes in the telecommunications industry in Japan since 1985 are reviewed below and accompanied by policy proposals to accommodate the changes in industry structure.

* Introduction of competition and regulatory policy

Privatisation of NTT Public Corporation and the introduction of competition

Prior to 1985 the telecommunications business in Japan basically operated under a state monopoly. Domestic services were monopolised by NTT Public Corporation and international services were monopolised by KDD (Kokusai Denshin Denwa Ltd). This system was maintained until 1985 when NTT Public Corporation was privatised and competition was introduced. NTT is regulated by the Nippon Telegraph Corporation Law (NTT Law), while the telecommunications business is regulated by the Telecommunications Business Law (TBL).

When a legal monopoly was awarded to NTT and KDD, regulations such as price control were justified to prevent abuse of monopoly power. These rules were required to restructure the regulatory system in a competitive environment. It is, however, preferable to minimise government intervention in order to rely on market mechanisms, and to leave competitive matters to surveillance of illegal conduct via anti-trust laws.

The regulatory framework introduced in 1985 was not free from the vestiges of the monopoly years (FUKE, 2000). Although intervention in the day to day operation of NTT is far from negligible, this paper focuses on TBL.

Competition and regulatory policy

The primary objective of the TBL is to protect consumers in circumstances where one or more carrier has market power and asymmetry in information over consumers exists. Regulations on entry and prices are the most important. The scope and level of regulation were considered to be different according to market segments, namely POTS and value added services. The TBL classified telecommunications carriers into two categories. Type 1 carriers are those offering services on their own telecommunications circuit facilities, whereas type 2 carries provide services by leasing telecommunications circuit facilities from Type 1 carriers (table 1).

The rationale for the rigid regulation imposed on type 1 carriers was due to the fact that they offer basic services essential to business activities and the daily lives of consumers. Type 2 carriers are subject to less rigid regulation to promote the development of various value added services. "Facilities business" is regulated and "services business" is free of regulation. The calcification of carriers into two categories based on the ownership of telecommunications circuit facilities was pioneering. It reflected a layered structure, although the physical and service functions were not specified separately in the regulation of type 1 carriers. It also avoided the vagueness surrounding the boundary between basic and enhanced services in the U.S.A. and contributed to the prognosticability of regulation.

Before going into business as a type 1 carrier, companies must first obtain permission from the Minister of Posts and Telecommunications (MPT). The TBL listed five criteria to be fulfilled before such an authorisation can be granted:

--the telecommunications services are appropriate in light of demand in the business area.

--telecommunications facilities in the business area will not become excessive.

--the applicant shall have an adequate financial basis and technical capability to properly perform his or her telecommunications business.

--the telecommunications business plan shall be reliable and feasible.

--the introduction of the telecommunications business shall be appropriate for the sound development of telecommunications in general.

The first two criteria were called "demand-supply coordination clauses". New entry was permitted if it did not cause excess capacity in the market. Further, entry was permitted separately according to the subdivided business areas of local / long-distance / international and fixed / paging / cellular / PCS (4). For example, only two new entrants were admitted into the international fixed market and NTT continued to be barred from the international market. This kind of "regulated competition" is not consistent with the idea of relying on market mechanisms and did not contribute to enhancing consumer welfare.

Moreover, excessive price regulation did not contribute to consumer protection. All type 1 carriers were required to seek the Minister's approval of their prices calculated by the "rate of return" method. Price regulation accompanying entry regulation led to "managed competition" and gave carriers little incentive to increase productivity (FUKE, 2000, pp. 32-34, for empirical analysis). There was no theoretical basis for regulating the prices of new entrants that did not enjoy the significant market power held by NTT and KDD when competition was introduced.

Another of the TBL's objectives is to ensure fair competition among carriers. The rules (5) governing the interconnection of NTT's essential facilities and new entrants' networks are especially important as long as NTT retains significant market power in the local telecommunications facilities that are essential for the entry of other carriers. One of the problems with the concept of fair competition was that the regulator adopted an undecided stance between structural separation and conduct regulation. Although structural separation was considered at the time of the privatisation of NTT Public Corporation in Japan, it was not implemented. The question was left open, with the privatisation of NTT Public Corporation seen as a priority.

On the other hand, the TBL enforced in 1985 did not make substantial provisions for interconnection. The absence of interconnection rules meant that interconnection conditions were settled through negotiations between carriers concerned, and it brought about severe disputes between the parties. As one of the ways to ensure fair competition is structural separation, the discussions on telecommunications policy centred on the divestiture of NTT until the new interconnection rules were enforced in 1997 and NTT was reorganised under the holding company structure in 1999.

* Development of competition and the revision of TBL and NTT law

Competition in the telecommunications industry developed gradually regardless of the insufficient regulatory framework. Price and entry regulation were subsequently relaxed. Following these changes, interconnection rules were introduced and NTT was reorganised.

Price regulation

Regulation of the prices of value added POTS services such as call waiting was relaxed from approval by the Minister to notification of the Minister in 1995. The prices of mobile services were deregulated to notification of the Minister in 1996, and this change contributed to the rapid growth of cellular services. Significant deregulatory measures were taken in 1998. For example, price cap regulation was introduced for local telephone services and the local leased line services of NTT. The prices of other services provided by the NTT and those offered by new entrants are required only to notify the Minister, instead of getting approval from the Minister. Although considerable deregulatory measures were taken, they suffered from a lack of objectiveness. No significant market study based on market definition was performed.

Entry regulation

In the case of entry regulation, "demand-supply clauses" were abolished in 1997. The rules on foreign ownership were also relaxed. The ownership of carriers by foreign undertakings was limited to one third in 1985, but control was abolished in 1997 for carriers other than NTT and KDD. The purchase of J-fone by Vodafone was the product of this revision. In the case of NTT and KDD, foreign ownership control was revised to allow for up to 20%. KDD Law was abolished in 1998 and the ownership control of KDD consequently disappeared. The foreign ownership limit of NTT stock was enlarged to one third in 2001. However, the minimum holding obligation of one third by the government has remained, which is hard to justify with economic theory.

Interconnection rules

The establishment of interconnection rules had to wait until 1997, when new rules were finally introduced. The intra-prefecture telecommunications facilities of NTT are treated as "designated telecommunications facilities (6)" and special obligations, including the unbundling of network functions, were imposed. The long-run incremental cost (LRIC) method was also introduced to calculate interconnection charges.

The report of the MPT's study group on the long-run incremental method model (MPT, 1997) defines "long-run incremental cost" as "the cost calculated on the basis of the network model that is built on the most cost efficient and modern technologies". The term "long-run incremental cost" has a somewhat theoretical nuance. However, actual application depends on policy goals (NOAM, 2001, p. 114). In the case of the telecommunications services offered on common telecommunications facilities, common cost and joint cost exist. As the undertaking cannot recover its cost by charges based on costs that exclude common and joint costs, it is necessary to take into account some mark-up on incremental cost. As it is difficult to find a theoretical level of mark-up, the level of mark-up is somewhat arbitrary. The other problem is that this mark-up is based on the theoretically most efficient network model, and companies cannot recover the cost of facilities actually built in the past. Thus it is important to understand the LRIC as a kind of pro-competitive policy whose simple and pure application may have a negative impact on the development of the telecommunications industry (FUKE, 2003b).

Reorganisation of NTT

NTT was reorganised into a holding company structure in 1999. Two local companies (NTT-East and NTT-West), one long distance company (NTT Communications), one cellular company (NTT DoCoMo) and one value added service company (NTT Data) operate under the holding company. The purpose of the reorganisation was to secure fair competition by dividing the companies that control essential facilities from other companies that offer competitive services by interconnecting with essential facilities. The businesses of companies that control essential facilities, namely two local companies, are limited to intra-prefecture services.

However, this is a compromise between fair competition and the rational operation of NTT, and did not offer a final solution in terms of structural separation. By separating local companies from other companies including a long-distance company, fair competition was supposed to be secured between NTT group companies and their competitors. NTT was also expected to pursue rational operation of its own group companies under the holding company. But fair competition and rational operation are not always consistent. This problem intensified with the diffusion of the internet, which naturally crosses prefectural boundaries. While discussions of complete divestiture of NTT companies continue, NTT is requesting the removal of the line of business control.

Asymmetric regulation

Formal asymmetric regulation was introduced in 2001 with the revision of the TBL (table 2). In fixed line services, the facilities of carriers with a market share of over 50% of fixed subscriber lines for each prefecture are to be designated as "Category 1 designated facilities", and carriers that have designated facilities are to be more strictly regulated regarding charges, tariffs, interconnection and fair competition. In cellular services, the facilities of carriers with a market share in excess of 25% of cellular subscribers in each prefecture are designated as "Category 2 designated facilities", and the carriers concerned are burdened with more severe regulation regarding interconnection and fair competition. As the designation was not based on the market definition and evaluation of market power, the regulation is rather arbitrary. After the internet became an important force in the market, the simple application of this regulation to online services proved more problematic.

* Structural changes in the telecommunications industry

While the Japanese telecommunications community was wasting time on barren discussions regarding the divestiture of NTT, the telecommunications industry saw structural changes. These changes have taken place in four dimensions:

* Development of competition

* Rapid growth of mobile services and the Internet

* Decline of POTS

* Development of media convergence with the change from vertical integration to layered separation

Development of competition

Since the introduction of competition in the telecommunications industry in 1985, the share of the incumbent (NTT) has decreased, especially in the long-distance market. With the introduction of interconnection rules in 1997 and the adoption of carrier pre-selection in 2001, competition has developed in the local call market. Japanese carrier pre-selection is unique, as users may register preferred carriers according to each of four call categories: local, intra-prefecture long-distance, inter-prefecture long-distance and international.

As shown in Figure 1, the NTT group now has a 55.7% share of the local market, while its share in the inter-prefecture long-distance market was 43.7% as of March 2005. The only market in which the NTT group still holds a significant market share is traditional metallic subscriber lines.

Growth of mobile services and the internet

The number of subscribers to mobile (cellular and PHS) telephones exceeded that of fixed telephone lines in fiscal 2000 and reached 91.4 million at the end of March 2005. Fixed line (POTS and ISDN) subscribers, on the other hand, decreased to 59.6 million (figure 2). Mobile subscribers per 100 inhabitants numbered 71.6, while fixed line services totalled 46.7. Revenues from mobile services reached USD 64,424 million in fiscal 2002 and exceeded fixed line revenues, which have been falling since fiscal 2000.

[FIGURE 2 OMITTED]

Since NTT DoCoMo launched the i-mode service in February 1999, the number of users accessing the internet via cellular telephones has grown rapidly (figure 3). This figure reached 75.1 million (about 86.4% of cellular subscribers) by the end of fiscal 2004. Japan is unique in its global internet usage in that access via cellular commands an important role. NTT DoCoMo started the first 3G service in the world in October 2001 with W-CDMA, and KDDI followed in April 2002 with cdma2000. The number of users of 3G services is also showing rapid growth (figure 4). By the end of July 2005, the total number of 3G users exceeded 33.7 million (about 38.3% of cellular users). Cellular is becoming a significant tool for high-speed internet access.

[FIGURE 3 OMITTED]

As for internet access via fixed lines, broadband access has grown rapidly (figure 3). The number of users of broadband internet services reached 19.5 million in March 2005. Around 40% of households are now connected via broadband. Although DSL dominates the market with 13.7 million users, recent growth in FTTH is remarkable. The number of users of FTTH reached 2.8 million and the net increase in users in the first quarter of 2005 exceeded that of DSL for the first time. About 13.1% of broadband users are now on FTTH.

One of the characteristics of the Japanese FTTH market is that both facilities-based and service-based competition has developed. In the wholesale market, NTT local companies and electric power companies are competing. In the retail market, service providers including Softbank BB are competing with NTT local companies and electric power companies.

DSL services have grown rapidly owing to the aggressive marketing of Softbank BB that took advantage of cheap regulated line-sharing charges (FUKE, 2003b). The MIC also obliged NTT local companies to unbundle FTTH at low charges. Softbank BB set its retail prices for FTTH and DSL services very low (7). To compete with Softbank BB's cheap DSL and FTTH services, electric power companies also marketed FTTH services very cheaply and NTT local companies followed suit. Not only intra-platform competition, but also inter-platform competition has developed in the broadband internet access market and that has contributed the growth of cheap and fast internet. According to the ITU (ITU [2004]), the broadband service in Japan is the most advanced in the world in terms of price and speed.

Decline of POTS

With the growth of broadband, IP telephony has begun to be widely deployed (8) and even NTT local companies have launched IP telephony services on FTTH. On top this, new entrants started to offer telephone services by utilising NTT local companies' unbundled metallic subscriber lines in 2004. NTT local companies were obliged to reduce monthly basic charges and call charges. Traditional telephone carriers are suffering from revenue losses (figure 5 & 6). The revenues of both NTT local and long-distance companies are decreasing at an annual rate of about 20%. Although they are retaining nominal profits by restructuring their businesses, especially via redundancies, their POTS businesses do not seem to be sustainable in their present state. The diffusion of mobile and broadband internet has changed the structure of the telecommunications industry and hurt traditional carriers.

Development of media convergence with the change from vertical integration to layered separation

This impact of this phenomenon is not limited to carrier finances. The diffusion of broadband internet and 3G cellular blurs the boundary between telecommunications and broadcasting. While broadcasting over the internet is already available, terrestrial digital TV services were launched in December 2003 and broadcasters are planning to offer digital services over 3G cellular terminals.

The Info-communications industry used to be vertically integrated, with a clear boundary between the media. With the diffusion of the internet, especially broadband internet, this structure has been changing. Any kind of contents can be divided into packets and transmitted on the internet as long as TCP/IP is observed. On the other hand, packets can be transmitted over any physical network as TCP/IP is defined only by software.

Thus the strict links between physical, service and content layers are cut off. Horizontal separation of the media industry according to three layers--physical, network and content layers--is developing (Figure 7). It is becoming an urgent task to revise the regulatory framework of the info-communications industry to accommodate these changes. One of the leading trials is the introduction of the EU's new regulatory framework (FUKE, 2003a).

[FIGURE 7 OMITTED]

* Revision of regulatory framework

Although the TBL has been revised several times since 1985, the revisions were made within the framework of traditional POTS. The rapid growth of broadband internet and internet access via cellular were not taken into account. With the wide diffusion of the internet, it is becoming outdated to try and encompass the free internet that has developed in the unregulated world with the rules of regulated telephony.

The Telecommunications Council, a consultative body organised by the MIC, published a series of reports on pro-competitive policies to promote IT revolution (MIC, 2000, 2002a, 2002b) and invited comments from interested parties. Although the MIC's effort to make its decision-making process transparent is to be evaluated, it has failed to reconcile the difference in opinions between NTT that requested greater freedom in business operation and new entrants that were interested in further regulation of NTT. Through the political compromise reached behind the scenes, the MIC revised the TBL in 2003 in response to these changes. The ministry claims that "this revision was to accommodate the changes from POTS to the internet, and that it made overall revision of the law, including entry and price regulation" (MIC [2003a]). In what follows I evaluate the revision focusing on six points.

Relaxation of entry regulation

The categorisation of carriers into type 1 and type 2 was abolished (9). Only those carriers with large telecommunications circuit facilities are required to register with the Minister, and other carriers may offer their services by notification of the Minister, regardless of the ownership of telecommunications circuit facilities. According to the "Regulations for Enforcement of the Telecommunications Business Law" of MIC that specifies detailed conditions based on the TBL, the carriers that install their subscriber lines within the boundary of a single city or town and trunk transmission within the boundary of a prefecture may start their services by notification, while other carriers are required to register. If we apply this rule to former type 1 carriers, about three thirds are required to register. The Ministry explains that, in the case of registration, the only judgment it will make is whether applicants have violated laws and rules in the past and whether they are observing fair competition conditions. The ministry will draw a conclusion within 15 days of application and accept notifications without any administrative judgment (MIC, 2003b).

Whether or not this will lead to significant deregulation depends on the actual application of the law. According to the law, the Minister shall reject registration in cases where: "the start of the business is not desirable for the sound development of the telecommunications industry". The law further specifies that: "rights of way will be awarded to carriers that have obtained authorisation from the Ministry". It lists two criteria for such authorisation:

* Applicants should have adequate financial resources and technical capabilities to properly conduct telecommunications business.

* Applicants' telecommunications business plans should be reliable and feasible.

If we put these provisions together, for carriers that require rights of ways (most former type 1 carriers), new entry conditions are not much different from the old individual permission system.

Total deregulation of tariffs

Tariffs are totally deregulated except for the basic services provided by two NTT local companies (table 3). In the case of basic services such as local analogue telephone services and public payphone services, some obligations including prior notification and publication of tariff and service obligations based on the tariff are to be imposed. As only a few carriers other than two NTT local companies offer these basic services, these obligations actually target the latter. Price-cap regulation is imposed on NTT local companies' designated services including basic services. The tariff regulation of NTT local companies remains unchanged. In the case of other carriers, tariffs are totally deregulated. Even prior notification and publication of tariffs is not required. The terms and conditions may be settled through individual negotiations between carriers and users. If disputes arise between carriers and users, they should be settled through ex post dispute handling procedures.

Although this deregulation should be valued as a response to the development of competition, it suffers from three flaws. The first flaw is the confusion between wholesale and retail markets. The MIC imposed regulation on NTT local companies' retail services offered based on category 1 designated facilities. However, the essentiality of some wholesale facilities to competitors in the retail market does not necessarily lead to regulation of the retail products offered by the facilities owner. If the retail market is competitive, the regulation of retail products is not justified. The retail market should be studied independently. The second flaw is the lack of economic market evaluation based on market definition. Although the MIC published a report on the evaluation of competition (MIC, 2004) in June, 2004 (10), its conclusions are not reflected in the new regime.

Although this deregulation should be valued as a response to the development of competition, it suffers from three flaws. The first flaw is the confusion between wholesale and retail markets. The MIC imposed regulation on NTT local companies' retail services offered based on category 1 designated facilities. However, the essentiality of some wholesale facilities to competitors in the retail market does not necessarily lead to regulation of the retail products offered by the facilities owner. If the retail market is competitive, the regulation of retail products is not justified. The retail market should be studied independently.

The second flaw is the lack of economic market evaluation based on market definition. Although the MIC published a report on the evaluation of competition (MIC, 2004) in June, 2004 (11), its conclusions are not reflected in the new regime.

The third shortfall is related to the information asymmetry between carriers and consumers. Consumer interests may not be very well protected by ex post "disputes handling procedures" when asymmetry in information between carriers and consumers persists. Carriers should at least be obliged to publish the tariffs of services supplied to individual consumers

Asymmetric regulation

Asymmetric regulation, which was introduced in 2001, continues under the new regime. Category 1 and 2 telecommunications facilities are designated by simply applying the share of subscriber lines or subscribers, and the price of the basic services provided by NTT local companies is still regulated. As the tariffs charged by other carriers are totally regulated, the asymmetry between NTT local companies and other carriers is significantly increased, as explained above. According to the EU's "2003 framework", ex ante regulation is imposed on the dominant carriers of a non-competitive market, and the market should be defined according to detailed analysis (FUKE, 2003a). If we apply this rule to the Japanese market, the designation of carriers with market power only by the share of number of subscribers and the imposition of special obligations to these carriers lacks theoretical justification.

If we look at the share of carrier pre-selection according to market segmentation shown in figure 1, each call market of POTS has become competitive. It is therefore unreasonable to impose special ex ante obligations on NTT local companies that are not applied to other carriers.

In the case of the cellular market, NTT DoCoMo holds a 56.3% market share, as shown in table 4. However, the net increase in NTT DoCoMo subscribers in fiscal 2003 and 2004 was lower than that of KDDI (figure 8), which dominates the 3G market (figure 3). If we consider not only total market share, but also changes in the shares of net increases in subscribers and 3G subscribers, it is unreasonable to designate carriers with over 25% share in each prefecture (12).

[FIGURE 8 OMITTED]

Unbundling obligation

The unbundling obligation of NTT local companies does not reflect Japanese market conditions (FUKE, 2003b, 2005). As the FTTH market becomes increasingly competitive (table 5), inter-platform competition between DSL, cable modem, FTTH and 3G cellular (13) and wireless LAN and intra-platform competition in FTTH market is developing. Although the market share of NTT local companies in the wholesale market is still very high, this is partly because the MIC imposed unbundling obligations with low charges. If we take into account FTTH installed by electric power companies (table 5), there are scant theoretical grounds for regarding subscriber optical fibre as essential facilities (FUKE, 2003b).

NTT local companies' business area

The revision does not solve the conflict between the line of business control on NTT local companies and the diffusion of the internet. In the case of POTS, it was feasible to divide the business areas between intraprefecture and inter-prefecture, although this is a mirror copy of AT&T's divestiture 20 years ago. In the case of the internet, which is characterised by a global reach, an artificial boundary is no longer sustainable.

One example is the internet access services of NTT local companies. They are allowed to offer services including internet access services that terminate within the boundary of a prefecture, but were obliged to offer the service on an intra-prefecture basis by leasing inter-prefecture parts of the transmission from other carriers. This surely deprives the services of efficient operation. It is against consumer interests to divide seamless internet services artificially into intra and inter prefecture segments. The inconsistencies between regulation and the changing structure of the industry are yet to be resolved.

Media convergence

Although the Ministry claims that the revision is to accommodate the changes from POTS to the internet (MIC, 2003a), it fails to take into account the media convergence brought about by the diffusion of broadband internet access. Various contents are distributed over the internet and one cannot classify these as either telecommunications or broadcasting. As for broadcasting, digital terrestrial TV started in 2003 following digital satellite service in 2001. Interactive services and distribution of contents to 3G cellular are expected.

The "Law Concerning Broadcast on Telecommunications Service" was enacted in 2001 and the Communications Satellite broadcasters (14) and cable broadcasters may distribute their contents over the telecommunications network. It just regulates the distribution of broadcasting contents over the internet as broadcasting. The MIC did not permit the distribution of digital terrestrial television broadcasting contents over the IP network (15). The basic regulatory framework was not changed and each media is regulated by individual law. Telecommunications are regulated by the TBL and broadcasting is regulated by "Broadcast Law" or "Cable Television Broadcast Law." Content distribution via broadband internet is handicapped by the "Copyright Law" that requires complicated copy right procedures for the IP based distribution of contents.

The revision does not solve the basic problem that the regulatory framework designed at the time of vertical integration is no longer viable given the layered structure of the info-communications industry.

* Conclusions

Although the revision of the TBL of Japan introduced in 2004 is claimed to be a form of deregulation, taking into account the migration from POTS to the internet, it is actually based on the rules of traditional telephony. As a result, revision of the TBL does not fully respond to the changes analysed above. It is necessary to design and introduce a new regulatory framework to accommodate changes in industry structure. It is especially important account for the change from vertical integration to a layered structure and accordingly from intra-platform to inter-platform competition.

Firstly, it is important to define the market based on the clear distinction between wholesale and retail markets. As discussed above, wholesale and retail functions are becoming increasingly independent within a layered structure. Even if a carrier is dominant in a wholesale market, this does not necessarily mean that it is also dominant in a retail market where services based competition has progressed. The regulation of incumbent carriers should be revised according to the development of competition in the wholesale and retail market respectively.

Secondly, it is important to establish technological neutrality in physical layer competition. For example, in the rapidly developing market of broadband internet, various access technologies such as DSL based on traditional metallic cables, FTTH, cable modem, wireless LAN and 3G cellular are competing and it is not possible to forecast which technology will prevail in the long run. Regulations such as the unbundling obligation of FTTH access are not desirable, as they only account for intra-platform competition and favour or discourage particular technologies. The unbundling obligation of fixed metallic subscriber lines should be reviewed as these technologies progress. The evaluation of market competitiveness currently being carried out by the Ministry will hopefully reach this conclusion without prejudice to status quo.

Thirdly, it is necessary to fully accommodate changes in service layers from a kind of public utility to a commodity. In the areas where market failure cannot be found, ex ante sector specific regulation should be abolished. With the development of services based competition, price regulation of incumbent carriers' retail local access services and call services should be revised.

However, the importance of consumer protection should not be neglected. As telecommunications services increasingly become commodities, many deregulatory initiatives are being taken. However, an asymmetry in information remains, particularly between carriers and individual users. If everything is entrusted to the hands of market mechanisms, consumers are likely to suffer. A mechanism to protect consumers from inadequate information should be maintained.

Fourthly, it is important to bring consistency to content layer regulation. I admit that it is extremely difficult to reach a consensus on this point among the various players in content layer. However, the regulations based on media are not sustainable in the broadband internet era.

Lastly, the importance of an inter-layer view point should be stressed. The change from vertical integration to a layered structure does not necessarily exclude inter-layer regulation. As the EU admits (European Union, 2002, recital [10]), the regulation under a layered structure will not prohibit an undertaking from engaging in businesses in various layers. As figure 9 shows, there are variances in business activities in the broadband internet market. As for market failure, it is necessary to take into account the leverage of market power in one layer to another layer. In the case of a vertically integrated telecommunications industry, market power in the upstream market that affects competition downstream has been discussed.

[FIGURE 9 OMITTED]

However, market power under a layered structure may affect the competition in both the upstream and downstream markets. Market dominance in the content layer may affect competition in the service layer, and inversely market dominance in the service layer may affect the competition in content layer. For example, if a network service provider that owns killer content rejects the distribution of this content by other network service providers, this will affect competition in the network service layer. On the other hand, if a network service provider with market power in the network service layer controls contents, it will affect competition in the content layer. It is consequently necessary to conduct an inter-layer review of the info-communications market. This does not mean the introduction of sector specific ex ante regulation, but points instead to the need to introduce an inter-layer view point in ex post regulation via competition law.

(*) This is the revised version of a paper titled 'Managing Structural Changes in Telecommunications' presented at the ITS 15th biennial conference held in Berlin in September 2004.

This paper is based on a study supported by The Telecommunications Advancement Foundation.

(1) As for telecommunications and regulation, see BALDWIN & CAVE, 1999; CAVE, 2002; and GERADIN & KERF, 2003.

(2) The existence of market power alone does not justify ex ante regulation by sector specific law.

(3) The MIC is the successor to the MPT (Ministry of Posts and Telecommunications) created when Japanese government organisation was restructured in 2001. It was formerly known as the MPHPT (Ministry of Public Management, Home Affairs, Posts and Telecommunications) in English.

(4) The Ministry's confirmation that the subdivision of businesses did not exist in 1996 launched a wave of mergers and acquisitions among telecommunications carriers in Japan.

(5) Interconnection rules are also expected to enhance consumer welfare through the effect of network externality.

(6) Japan is divided into 47 prefectures. The notion of designated facilities is similar to essential facilities, except that the latter include competitive intra-prefecture long-facilities. Line sharing is not specified in this rule and caused further conflicts with the introduction of DSL.

(7) Some doubt the long-term success of this strategy (CRANDALL, 2005, p. 144).

(8) According to Softbank Corp, the largest ADSL provider in Japan, its IP telephony service had attracted about 4.6 million users at the end of June 2005.

(9) All type 1 carriers were required to obtain the Minister's permission to start telecommunications services, regardless of the size of their business.

(10) This is a first effort to evaluate market conditions by applying the results of academic studies. This effort will hopefully be continued and reflected in actual policy revisions.

(11) This is a first effort to evaluate market conditions by applying the results of academic studies. This effort will hopefully be continued and reflected in actual policy revisions.

(12) No adequate explanation is given for why a 50% share is applied in the fixed line market and 25% in the cellular market.

(13) NTTDoCoMo started to offer cellular terminals that respond to full browser

(14) Japanese satellite broadcasters are classified into Communications Satellite (CS) broadcasters and Broadcasting Satellite (BS) broadcasters based on historical background.

(15) This is expected to save the major investment required to provide digital terrestrial broadcasting in remote areas.

References

BALDWIN R. & CAVE M. E. (1999): Understanding Regulation, Oxford University Press.

CAVE M. E. (2002): Handbook of Telecommunications Economics volume 1 Structure, Regulation and Competition, North-Holland.

CRANDALL R. W. (2005): Competition and Chaos: U.S. Telecommunications since the 1996 Telecom Act, Brookings Institution Press.

European Union (2002): Directive 2002/22/EC of the European Parliament and of the Council of 7 March 2002 on a common regulatory framework for electronic communications networks and services (Framework Directive).

FUKE H.:

--(2000): "Structural change and deregulation in the telecommunications industry (in Japanese)", NTT-Publishing.

--(2003a): "Evaluation of New Regulatory Framework of European Union-From Japanese Perspective", Presented at ITS European Regional Conference in Helsinki.

--(2003b): "The spectacular Growth of DSL in Japan and its Implications", in COMMUNICATIONS & STRATEGY, no. 52, IDATE.

--(2005): "Rethinking the Regulation for Wholesale FTTH services", a paper presented at the ITS 16th European Regional Conference.

GERADIN D. & KERF M. (2000): Controlling Market Power in Telecommunications, Oxford.

ITU (2004): ITU Internet Report: The Portable Internet, 6th edition.

MIC:

--(2000): First Report on Desirable Pro-Competitive Policies in the Telecommunications Business Field for Promoting the IT Revolution.

--(2002a): Second Report on Desirable Pro-Competitive Policies in the Telecommunications Business Field for Promoting the IT Revolution.

--(2002b): Final Report on Desirable Pro-Competitive Policies in the Telecommunications Business Field for Promoting the IT Revolution.

--(2003a): Explanatory Document (in Japanese). See: http://www.soumu.go.jp/kyoutsuu/syokan/gaiyo/030317_1_01a.pdf

--(2003b): Explanatory Document related to the announcement of the opening of public comments on "Regulations for Enforcement of the Telecommunications Business Law" (in Japanese).

--(2004): Competition Review Fiscal 2003 (in Japanese).

MPT (1999): The report of the study group on the long-run incremental method model (in Japanese).

NOAM E. M. (2001): Interconnecting the Network of Networks, The MIT Press.

OECD (2004): Benchmarking Broadband Prices in the OECD.

Hidenori FUKE

Kansai University, Japan

Table 1: Type 1 and Type 2 Carriers

      Type                 Definition                Entry

Type 1              Own telecommunications       Permission
                    circuit facilities

          Special   Lease telecommunications     Registration
                    circuit facilities (big)
Type 2
          General   Lease telecommunications     Notification
                    circuit facilities (small)

      Type                    Exit               Price/Service

Type 1              Permission                   Approval

Type 2    Special   Notification                 Notification
                    (ex post)                    (ex ante)

          General   Notification                 No regulation
                    (ex post)

Table 2: Asymmetric regulation 2001
                               Dominant                   Non-dominant

                   Fixed line              Mobile

Service  Charges   Price cap               Notification   Notification
         Tariff    Approval                Notification   Notification

Interconnection    Approval and publica-   Notification   Notification
                   tion of interconnec-    and public-    of inter-
                   tion tariff             ation of       connection
                                           interconnec-   agreement
                                           tion tariff

Fair competition   Fire-wall (prohibition of holding      Order to
                   concurrent board positions)            remedy
                                                          business
                   Prohibition of the use of information  operation
                   other than interconnection, prohibi-
                   tion undue discrimination of order to
                   suspend or remedy

Table 3: Tariff and other terms and conditions 2003

                              Old

Type          General                  Prior notification /
                                       publication
                                       Ministerial order to
                                       change in following
                                       cases:
                                       --lack of proper and
                                       clear basis for
                                       charge
                                       --unfair
                                       discrimination
                                       --lack of special
                                       treatment in case of
                                       emergency

              Category     Specific    Approval by MPHP
              designated   services    Price cap (charges)
              facilities

              Others                   Prior notification /
                                       publication
                                       Ministerial order to
                                       change (same as
                                       general)

Category designated                    Prior notification /
facilities                             publication
                                       Ministerial order to
                                       change (same as
                                       general)

Type          Special                  Prior notification /
                                       publication

              General                  No regulation

              New

Basic services (universal services)    Prior notification /
                                       publication of tariff
                                       Ministerial order
                                       to change in
                                       following cases:
                                       --lack of proper
                                       and clear basis for
                                       charge
                                       --lack of clear
                                       specification of
                                       responsabilities of
                                       carriers and users
                                       Restriction of
                                       ways of line
                                       usage
                                       --unfair
                                       discrimination
                                       --lack of special
                                       treatment in case
                                       of emergency
                                       --unfair
                                       competition

Category      Designated   Specific    Prior notification /
designated    services     services    publication of tariff
facilities                             Ministerial order
                                       to change (as
                                       above)
                                       Price cap
                                       Accounting
                                       separation
                                       Service obligation

                           Others      Prior notification /
                                       publication of tariff
                                       Ministerial order
                                       to change (as
                                       above)
                                       Accounting
                                       separation
                                       Service obligation

              Others                   No regulation (*)

Category designated facilities         No regulation (*)

Others                                 No regulation (*)
                                       Obligation to
                                       explain
                                       Conditions of
                                       service
                                       Prompt handling
                                       of claims

(*) Carriers with rights of way have obligation of service

Table 4: Cellular subsribers as of March 2005

             Subscribers    Share
                            (%)

NTTDoComo    48,824,900     56.1
KDDI         19,542,400     22.5
TUKA         3,589,600      4.1
Vodaphone    15,040,700     17.3
Total        86,997,600

Source: Telecommunications Carriers Association

Table 5: FTTH share (September 2004)

Retail (%)

NTT-E          31.07
NTT-W          28.66
Power          13.42
USEN           9.49
Others         17.35

Source: MIC

Wholesale (%)

NTT-E, W       77.09
Power          12.01
USEN           11.20

Source: the author's rough estimation based on MIC data

Figure 1: Share in carrier pre-selection (as of March, 2005)

                      Intra-Prefecture   Inter-Prefecture
             Local    long-distance      Long-distance    International

Unregister   18, 9        18, 3              28, 0            35, 2
NCC          13, 7        13, 7              14, 8            13, 3
KDDI         12, 3        12, 3              13, 5            14, 4
NTT (Total)  55, 7        55, 7              43, 7            37, 1

Source: Myline (Carrier pre-selection) Carriers Association

Figure 4: 3G cellular in Japan

                      2001    2002    2003      2004     2005.6

NTT DoCoMo (W-CDMA)    90     330     3 045    11 501    13 710
au (cdma2000)                 360     13 509   17 935    18 723
vodafone (W-CDMA)              30      138      917      1 299

Source: Telecommunications Carriers Association

Figure 5: Revenue from local calls

             2000       2001       2002       2003       2004

NTT-East    3 905      2 701      2 108      1 687      1 281
NTT-West    3 884      2 701      2 118      1 747      1 361

Figure 6: Revenue from long-distance calls

                     2000      2001      2002      2003      2004

NTT-East             832       678       581       514       432
NTT-West             842       707       602       521       439
NTTCommunications   6 183     4 690     4 015     3 731